How will blockchain impact the financial industry?

20-05-2016 | Research

Distributed ledger technology, such as blockchain, has been gaining a lot of attention as the underlying infrastructure of Bitcoin. Thanks to the open architecture of blockchain’s programming code, many alternative use cases are rapidly being developed. How will this impact the financial industry?

Jeroen

van Oerle

Portfolio Manager

Patrick

Lemmens

Portfolio Manager

Speed read

Distributed ledger technology is hyped but here to stay

Adoption will be evolutionary rather than disruptive because of regulation

Companies involved in labor intensive, costly and lengthy processes are most at risk

A distributed ledger is a database that keeps track of who owns a specific asset. This asset can be physical or electronic. Examples are diamonds, real estate and currencies. An essential feature of the new technology is that it is distributed. Every participant can keep a copy of the ledger, which is updated automatically when new transactions occur. The best known example of such a distributed ledger technology is blockchain. Block chain is the underlying ledger technology behind Bitcoin, a cryptocurrency. All Bitcoin transactions are processed and recorded on the Block chain. Literally every Bitcoin transaction ever made is recorded and can be traced. Not necessarily traced to people, but traced to accounts.

Hyped, but here to stay

We think the technology is currently being hyped, as witnessed by the large investment flows from private investors. At the same time, we are convinced that this technology is here to stay in the long run. It is currently in its infancy stage and there are several challenges to overcome before mass adoption is possible. Regulatory and technical issues are most decisive. In addition, there is a need for standardization to overcome hurdles, which we believe is best accomplished through the creation of consortia that include all relevant stakeholders.

In the financial sector most resources are invested by banks, which have formed a consortium in R3CEV. For banks, this ‘administration 3.0’ technology will enable efficiency gains. Although disruptive use cases are theoretically possible, blockchain is most likely to be an evolutionary sustaining innovation. As with other technology, pre-conditions for incumbents to survive are technological competence and a proactive attitude.

Evolutionary, not revolutionary

We think blockchain technology will have a large impact on the financial sector. Still, we believe the rollout will be evolutionary rather than disruptive given the high level of regulation in the financial sector. We think this allows incumbents to react to the new technology and find ways to incorporate it into their current IT systems. We don’t think there will be only one version of blockchain, which allows for customization within specific industries.

It is too early to identify clear winners. A comparison can be made to the music industry where Napster was the first company to enable large-scale online distribution of music, but Spotify emerged as leader. The same can happen with blockchain. A lot of startups are private, which implies we either have to wait until they become public, or we have to look for investible venture capitalists with a focus on blockchain.

Although we cannot yet identify clear winners, we do see challenged business models. In the financial sector, there is an increasing influence of technology. Good examples of companies that are providing services for the financial sector are IBM, Accenture and Cognizant. Their main products and services focus on transforming legacy IT infrastructure. It can be questioned if there will still be demand for these services in a blockchain eco-system.

Challenged business plans with inefficient value chains

In our opinion, companies involved in the ‘quick win’ areas (costly, labor intensive and lengthy processes) are most at risk if they do not react to this new technology. The ‘middle man’ who is not able to provide value for his customers is expected to be disintermediated by distributed ledger technology. Key incumbents are likely to be investing in the technology in order to transition their current business model.

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